This article first appeared in The Edge Financial Daily on January 22, 2019

DRB-Hicom Bhd
(Jan 18, RM1.67)
Maintain outperform with a lower target price (TP) of RM2.10: DRB-Hicom Bhd announced that Proton Automobiles (China) Ltd and Perusahaan Otomobil Nasional Sdn Bhd had been served with a legal claim amounting to 860.6 million yuan (RM521 million) by Goldstar Heavy Industrial Co Ltd. This is in relation to the termination of the equity joint venture contract (EJVC) between Proton Holdings, Lotus Group International Ltd and Goldstar on Jan 22, 2018. Failure to defend itself against this claim will have a material financial impact on DRB-Hicom. We are keeping our forecasts at this juncture pending further clarity, though we would also like to highlight this potentially significant financial risk.

From the EJVC dated April 17, 2015, a joint-venture company, Goldstar Lotus Automobile Co Ltd (GLAC) was incorporated on Sept 25, 2015 to produce and sell Lotus cars, engines, auto parts and accessories, and to provide aftersales services in China.

GLAC had not yet commenced its business operations due to not having obtained the required manufacturing licence, with a deadline originally set for Sept 25, 2017 and subsequently extended to Dec 31, 2017 as a matter of good faith. The termination was then announced on Jan 22, 2018. As stated in the EJVC, failure to obtain the said manufacturing licence within the agreed time frame entitled either party to terminate the EJVC. Hearing of the claim has been scheduled for July 9.

This litigation may have a material financial impact on DRB-Hicom should it fail to defend itself against this legal suit, though management believes it has a fair chance. Cash and bank balances stood at RM2.8 billion as at September 2018. Pending further clarity, we keep our forecasts at this juncture though we would also like to highlight this potentially significant financial risk. The hearing date will be on Jul 9.

Despite this potential setback, the turnaround of Proton is on track with a strong demand for Proton X70. The number of bookings recorded is currently around 15,000 units, with local manufacturing (completely knocked down) expected to kick off in the second half of calendar year 2019. To recap, Proton has secured the mandate to manufacture and sell three Geely models, namely Boyue sport utility vehicle (SUV) (that is Proton X70), SX11 SUV and VF11 multipurpose vehicle. The agreement allows Proton to market the models to Brunei, Indonesia, Malaysia, Singapore and Thailand for a period of 10 years.

We maintain our “outperform” call on DRB-Hicom with a lower sum-of-parts-derived TP of RM2.10 as we raise our discount factor to account for these current uncertainties. We still like the group’s longer-term prospects premised on its Proton-led turnaround. Sentiment may take a short-term hit, however. — PublicInvest Research, Jan 18